Mexico’s bellwether case for sovereign debt restructuring

Author: | Published: 30 Nov 2012
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Whitney Debevoise
By 1984, Mexico had amassed sovereign debt stocks totaling around $96.6 billion. Whitney Debevoise, a partner with Arnold & Porter and a former US executive director of the World Bank explains how a new debt service programme nearly paved the way for recovery

It was not until 1989 that the then US Treasury Secretary Nicholas Brady proposed his debt reduction plan that was eventually adopted for debt-ridden countries across Latin America.

The plan was especially innovative in its use of a menu-styled creditor opt-in programme, important considering a long list of diverse financial obligations. Creditors could choose to convert their loans into bonds or provide new loans, for instance.

The Plan, which was overseen by the International Monetary Fund and World Bank, is widely understood to have been more successful than the loans provided earlier in accordance with economic reform requirements that might have slowed down recovery.

"Mexico completed the first Brady plan, and would've put restructuring behind it had it not been for the tequila crisis a few years later," Debevoise said.

Payback options for creditors were developed during negotiations with a geographically representative bank advisory committee composed of the commercial banks with the largest exposure to Mexican debt obligations.

The bonds issued to creditors in exchange for loans were backed by funds held at the IMF and the World Bank, with US Treasury bonds securing principal and interest payments on the restructuring plan bonds.

To Debevoise, Mexico's international debt relief programme was the bellwether case for sovereign debt restructuring.

Even so, he explains, there were a lot of technical issues to resolve. These included determining which debt would be excluded from private creditor negotiations, whether trade debt would be excluded (it was), and how to treat financings for moveable assets such as oil rigs.

Mexico's perfect storm

Mexico was able to service its debt in the years leading up to the crisis because of rising oil prices. Interest rates rose to record highs during the early 1980s as the US Federal Reserve sought to curb inflation. And the perfect storm hit Mexico, and Latin America generally, when petroleum prices declined and debt payments rose.

Just when Mexico seemed to have recovered from the debt crisis, its currency saw a sudden devaluation in December of 1994 amid growing concern over the quality of bank loans.

Quality capital reserves were further depleted by a run on Mexican bonds denominated in US dollars.

There were a lot of troubled banks that were liquidated by regulators or merged into healthier banks as the authorities sought to stabilise the banking system.

Mexico and other Latin American countries adopted more stringent capital and loan restrictions in the years that followed. This proved helpful when the US banking system tailspinned during the 2008 subprime mortgage crisis. Latin American banks largely avoided those types of investments.

"The regulation of banks became reasonably strict in terms of the levels of capital required," Debevoise said. "[Mexican] banks were not allowed to leverage the way banks in other countries did."

"[The crisis] lead ultimately to stronger economic fundamentals and a stronger appreciation among politicians of the need to retain a stronger banking system," Debevoise said. "Those lessons subsequently resulted in greater growth in those economies and more resiliency."

The Brady Plan has been discussed as an alternative to the European Central Bank's bailouts of sovereign debt. It might make less sense for the eurozone because most outstanding debt for distressed European countries is in the form of just one type of sovereign bonds rather than syndicated loans, however.

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See also

New regimes expected for LatAm renewables

Is Mist the next BRIC?




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